More predictable rates of return could help advisors if BoC stays on course

(May 22, 2003) Financial advisors can expect a little smoother sailing — or at least a clearer idea about where the rate of return winds are taking their clients’ portfolios — if Paul Jenkins and the Bank of Canada make good on their inflation targets.

Speaking this morning at the Economic Club of Toronto, the senior deputy governor re-stated the central bank’s inflation target. “As its ongoing contribution to sustained, good economic performance, the bank will remain focused on keeping inflation at 2%,” Jenkins said, also staking a claim to a form of nationwide support for the target. “The inflation target is not just the Bank of Canada’s target, but also the government’s … There is now broad support among Canadians for low inflation.”

Jenkins made the promise immediately after Statistics Canada released its April figures showing that inflation had eased to an annualized 3%, mostly due to a drop in gasoline prices. Falling inflation eases pressure on the Bank of Canada to continue raising interest rates. Continuing high price pressures, including gasoline, earlier in the year had led the Bank of Canada to raise interest rates, most recently in mid-April.

As well as gasoline and other energy prices, increases in insurance premiums and strong domestic demand led to price pressures and therefore increasing inflation sectors such as shelter and services, Jenkins explained. “In this environment, some indicators of short-term inflation expectations have edged up, although longer term expectations have remained around 2%.”

Canadians need not worry about deflation although it is a very real prospect in the United States, according to Jenkins, pointing to two major differences between the countries: the U.S. is a net importer of price-sensitive commodities while Canada is a net exporter, and the American economy is below capacity while the Canadian economy is at or near full capacity. Together, those factors make deflation an unlikely prospect in Canada, according to Jenkins.

The central bank’s commitment to controlling inflation through overnight interest rates may represent a good news-bad news equation for advisors. Low interest may discourage investors who do not grasp the real economic cost of higher rates, explains Roy Vokes, president of Agora Financial Services in Kleinburg, Ontario and a former banking executive. “People look favourably back at 10%, 12% and 14% interest rates but they didn’t realize what it really cost them on the other side.”

As well as low inflationary expectations, the tight control by the Bank of Canada of interest rates makes life at least a little easier for advisors, according to Vokes. “We’re looking for more predictability and stability in real rates of return. That will make our planning for the future clearer,” he predicted.

That will enable advisors to plan areas such as projected retirement income more clearly. “In discussion with clients you can count on a more stable and predictable real rate of return.”

Art Melo is a Toronto-based financial writer.

(05/22/03)